GROSS DOMESTIC PRODUCT

• The market value of all goods and services produced within a country in a given period of time.

• It can be measured as all the EXPENDITURES to buy the goods and services produced.

• It can also be measured as all the INCOME earned from producing the goods and services.

• Since every dollar spent is someone’s income, the two measures give the same result.

Gross Domestic Product »The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world.

Gross Domestic Product

Firms hire factors of production from households. The blue flow, Y, shows total income paid by firms to households.

Gross Domestic Product –Households buy consumer goods and services. The red flow, C, shows consumption expenditures.

Gross Domestic Product

Households save, S, and pay taxes, T. Firms borrow some of what households save to finance their investment.

Gross Domestic Product –Firms buy capital goods from other firms. The red flow I represents this investment expenditure by firms.

Gross Domestic Product –Governments buy goods and services, G, and borrow or repay debt if spending exceeds or is less than taxes

Gross Domestic Product

The rest of the world buys goods and services from us, X and sells us goods and services, M—net exports are X - M

Gross Domestic Product

And the rest of the world borrows from us or lends to us depending on whether net exports are positive or negative.

Gross Domestic Product –The blue and red flows are the circular flow of income and expenditure. The green flows are borrowing, lending, and taxes.

Gross Domestic Product

The sum of the red flows equals the blue flow.

Gross Domestic Product

–That is: Y = C + I + G + X - M

Expenditures

• Expenditures are purchases of goods and services.

• Expenditures are – Consumption (C)– Investment (I)– Government spending (on goods and services) (G)– Net Exports (X-M)

• Exports (X) • Imports (M)

Expenditures equal Income

• Expenditures= C + I + G + X – M

• All expenditures become someone’s income so

• Y (income) = C + I + G + X – M

Government

• Government spending:– Goods and services (G)

• Roads, health care, education, helicopters, police officers salaries, judges salaries.

• Government revenue: – Taxes– (Income from Crown corporations)– (Tariffs)– Less Transfers to persons (part of net taxes)

• GST rebates, unemployment insurance, pensions, subsidies• Interest on the debt (substantial)• NOTE: The gov’t is not buying services, so transfers are not

an expenditure.

Budgetary Deficits and Surpluses

• Spending– Goods and services

(G) + Transfers to persons (Tr)

• Revenue– Taxes (Tx)

• Net Taxes– Tx – Tr = NT

• Surplus G + Tr < Tx G < Tx – Tr G < NT

• Deficit G + Tr > Tx G > Tx – Tr G > NT

Savings and Investment

• Investment is financed by savings• Savings have three sources:

– Savings by households • The part of income households do not spend on

consumption or net taxes.• (S = Y - C - NT)

– Savings by governments• NT – G = savings

– Savings of foreigners• M – X = foreign borrowing

STOCKS AND FLOWS

• FLOWS– Income : the goods and

services produced each year

– Deficits: The excess of spending over income each year

– Investment: Goods produced to be used in production each year

– Surpluses: The excess of revenue over expenditures each year.

• STOCKS– Wealth: All the goods a

person owns. Wealth is the sum of past net saving.

– Debt: the sum of all past deficits less all past surpluses

– Capital: All the investment goods owned. Capital is the sum of past net investment